Piotroski is our top JSE portfolio

We have been tracking the JSE performance of all our portfolio strategies created on the trough of 20 Nov 2008 (11 weeks ago). So far the best performing one is the "pure-form" Piotroski strategy that only purchases shares with a Piotroski F-Score of 8 or 9, a Price-to-book ratio less than 1.15 and a PE ratio less than 1.5x the ALSI (about 12).

A scan is run on each Monday to seek out new candidates for inclusion in the portfolio and to sell any holdings that have their F score drop below 8 due to a results (final or interim)announcement. On 20th Nov 2008 (inception date) it aquired 9 stocks and on 20 January 2009 and 5th Feb it aquired one stock respectively. On 5th Feb DRD Gold announced their interim and their Piotroski score dropped from 8 to 4 and the share was disposed for a 135% profit.

As our backtests on the 2003 JSE crash showed, this portfolio strategy is also performing remarkably well in such a short space of time (for a so-called Value strategy that is). It is currently out-performing the ALSI by 1.69 times (36.8% total return versus ALSI's 21.7%) since inception on 20 Nov 2008. For the calendar year 2009, the Piotroski portfolio has shown 13.5% return versus the ALSI's 0.82% (that is a remarkable 12.68% outperformance this year so far, or 16x the ALSI return!) Click on the image below for a larger more detailed view.



Piotroski's strategy was also the top performing strategy on the AAII web site for 2008, the only strategy out of 50 they are running that showed a positive return on the US markets!



For a list of the Piotroski stocks we are holding, as well as those still qualifying for purchase (ie they have not "run away" and become too expensive) in addition to a monthly email update on new candidates and current holdings that no longer qualify and must be sold, email powerstockz@gmail.com for an order form for R360 for 12 months of Piotroski Strategy Updates (SKU=PWS-PSU12M)

PowerStocks ValueFinder

It now makes logical sense for us to want to perform a "Value" screen on the JSE by seeking stocks that are "cheap" (have low PE's and low Price:Book ratios, as with the PriceFinder screen) but are ALSO "quality" (financially sound, as shown with Piotroski Screen). We can do this by combining the Piotroski rankings with those PE and Price:Book scans we did previously. We call this triple-combo screen our PowerStocks ValueFinder.

Using this screen yielded a portfolio of only six shares at the trough of the last Bear market, that grew an impressive 593% on an equal weighted basis or a staggering 1042% on a market-cap weighted basis. (The weighted basis is merely the method you use to contruct your portfolio.) Every single stock in this portfolio grew more than 250%. To pick such a small portfolio with such impressive results is truly remarkable.

The flow diagram below shows how the PowerStocks methodology successively screened the JSE down from 271 to 6 stocks in the trough of the last Bear market.

We bet you are just itching to see which stocks currently meet the ValueFinder criteria right? If you would like a complete ValueFinder report of ALL 425 JSE stocks then proceed to PowerStocks JSE Rankings Report. However we strongly suggest you resist temptation and read the next section first, as we will show an even MORE powerful refinement to the ValueFinder stock picking methodology.

NEXT UP : Even more powerful, the PowerStocks ValueScore

Piotroski JSE Candidates

In the last two posts we introduced Piotroski, showed how well it worked in the US markets, back-tested it on the JSE and came to the conclusion that is is an extremely powerful selection criteria for picking a portfolio of undervalued stocks with Price-to-book ratios less than 1 that are likely to significantly outperform the market in any subsequent recovery.

PowerStocks are now proud to make history and publish the first ever Piotroski Longs/Shorts candidate ranking tables for the JSE. These are stocks with price:book ratios less than 1 and Piotroski scores of 7-9 (longs) or Piotroski scores of 2 and below (shorts). The Long Table appears below as at 31 October 2008. (click for larger view)



Note that every time a company releases a set of results, its Piotroski scores will change since all the information comes from the financial statements. Also these stocks by definition will be obscure. As Piotroski notes, low Price:Book stocks are generally neglected by the market in favour of more glamorous stocks, and during bear markets like the one we are currently in, this is even more so.

Piotroski scores can be used for picking shorting candidates as well. According to research and practical experience of some fund managers, F scores of 2 and below are good candidates for "distressed stocks" that are unlikely to hold up in depressions, recessions or tough economic times. Even if you don't do short trading, it is advised you avoid these stocks. The Piotroski Shorts table is below:

We showed that even for those shares with price:book ratios >1, Piotroski showed a very strong correlation between growth and "F" scores. If you would like a detailed Piotroski Ranking of all JSE stocks (475 of them) together with their PE's and Price:Book values as at 29 October 2008, sorted according to the ValueFinder scoring/ranking method then email us at powerstockz@gmail.com to place an order for the report, which will cost R250.

NEXT UP : Combining it all together - the ValueFinder

Piotroski JSE Performance

As we saw from the previous post, the theory is you only apply the Piotroski scoring methodology to "undervalued" stocks with low price-to-net-asset-values (Price:NAV). The theory goes that the growth of these "distressed" stocks in the medium term (5 years) is closely correlated to the Piotroski "F" scores they achieved at the start of the assessment period.

PowerStocks put this to the test on the JSE, ranking the 5 year average growth of stocks together with their Piotroski "F" scores as at 28 April 2003 (trough of the last big bear market). We performed the tests with all JSE shares listed at that time and then only on those shares with Price:Book ratios of less than 1. The results are shown below:


The results are rather remarkable, confirming Piotroskis' theory for the JSE. Note how Piotroski is a great bear market screen for ANY stocks (shown by the blue bars) but worked especially well for "undervalued" stocks (shown by the red bars) when F>6. Note how portfolios of shares selected with F>6 significantly outperformed the ALSI and the group average growths.

Note how the average growth of the group P2Bk<=1 is much larger than the average growth of the entire group (All), confirming the theory we postulated that undervalued share portfolios are much more likely to outperform coming out of bear markets than other stocks (See Price-to-Book : An all-time classic)

We can state that historically, Piotroski "F" scores greater than or equal to 7 for "undervalued" shares showed significant out-performance to the group average (of undervalued stocks) and the all-share index (ALSI). It also showed a lesser but still significant out-performance for all stocks regardless of their price:book ratios.

The most important observation we can make here is that even though Price:Book has been shown to be a stong, safe selection criteria for potential growth stocks, Price:Book coupled with the Piotroski valuation significantly enhances portfolio performance. The almost 1,200% performance of the portfolio of "undervalued" shares with F greater than or equal to eight is double the group average of undervalued stocks (588%) and triple the growth of the market-cap based ALSI index (350%).

NEW : The Piotroski screen is our top performing portfolio we track on the JSE since 20 Nov 2008. You can view its performance coming out of the 2008 JSE crash over here.

NEXT : Piotroski JSE Candidates

Piotroski U.S Performance

The Piotroski method is currently the 3rd most successful value investing system, tracked monthly for the last 10 years by the American Association for Individual Investors (AAII). Over the last 10 years it showed 1,069% return, versus O'Neils CANSLIM (1,489%) and the Zweig method (1,800%).

CANSLIM and Zweig are however BULL MARKET investment strategies, and Piotroski is the only BEAR MARKET screen tracked by the AAII. Since we are in the throes of the 2nd largest bear market in 20 years on the JSE, we are very interested in Piotroski's methods!



Note how the Piotroski screen massively boosts the performance of low PB stocks. And look at how the Piotroski growth exploded from the trough of the 2003 bear and remarkably is showing 20% growth in 2008 when just about everything else is lying on the floor!

But how should we explain the poor performance of Piotroski's method in the mad bull run of 2006 and 2007 and its good performance in the current crash? Quite simply, in the peak of a bull run, everyone is chasing hyped up stocks and not the low PB stocks and in the bear run everyone comes down to the level of the low PB stocks and their value coupled with their sound "financials" from the "F"-Score starts shining through.

Given the current state of the markets now, it looks like a fine time to build up a Piotroski Portfolio! Here at PowerStocks we are going to do just that, building the first EVER published Piotroski Portfolio for the JSE, right in the midst of the 2nd largest JSE fall in 20 years. But first we need to test it to see if it works on the JSE. Sure, there is a 90% chance it should but at PowerStocks we like to back test our theories on the JSE first.

NEXT : Piotroski performance on the JSE

Introduction to Piotroski

Our previous writings showed how the trend in overseas markets for low price-to-book (PB) "value" stock portfolios to outperform high PB value portfolios was spectacularly confirmed on the JSE.

It has also been shown that large portfolios of low PB stocks outperform smaller portfolios, because in general, a few stocks in the low PB portfolio have to perform spectacularly, to make up for all the losses of the other stocks in the portfolio.

This is because many low PB stocks are low for a reason and as the lowest PB stocks are generally distressed, very few of them manage to claw out of the hole they are in. Having said that, our previous PB analysis on the JSE showed that very few low PB stocks (not more than 15%) "crashed and burned" and had you put together a portfolio in May 2003 of 10 or more low PB stocks you would have done rather nicely, especially if they had PE's between 2-4.

Nevertheless, it would be nice to apply some sort of financial "evaluation" to low PB stocks to further screen out "weaker" issues and focus on those most likely to have strong financial fundamentals turn in their favour in the short term, further accelerating their over performance of the ALSI, and allowing us to get good performance by only having to manage smaller less risky portfolios.

One particular person came up with such a methodology that is quite successful. He is Joseph Piotroski and he is a professor at the University of Chicago. His paper, “Value Investing: The Use of Historical Financial Information to Separate Winners from Losers”, available as a PDF here, was published in 2000. In that paper, Piotroski showed that by using a set of nine different fundamental signals taken straight from the companies financials, to screen among low P/B stocks, an investor could separate the winners from the losers. By buying only those stocks that had the highest scores, an investor could have outperformed the market by an average of 10% per year from 1976 to 1996.

Piotroski started by screening for the stocks with the lowest P/B ratios that were non-negative. This limits the strategy to true value companies. After the price to book ratio, nine other pieces of information were used, as follows:

1. positive earnings
2. positive cash flow from operations
3. increasing ROA
4. quality of earnings : operating cashflow > net income
5. decreasing long-term debt as a proportion of total assets
6. increasing current ratio, indicating increasing ability to pay off short-term debts
7. decreasing or stable number of shares outstanding
8. increasing asset turnover ratio, indicating increasing sales as a proportion of total assets
9. increasing gross margin

Each company is given either a one or a zero on each variable to create an "F"-Score ranging from 0 to 9. The strategy calls for buying every company with the requisite low P/B ratio and a "F"-score of eight or nine. As Piotroski's research shows, low P/B stocks with high rankings are less likely to go bankrupt or to fall drastically in price than are those with low rankings, so this further adds to our defensive value picking investment strategy.

NEXT : Piotroski U.S Performance